Contractors sitting pretty on record orders

Expectations of a boom year ahead for hard commodities is likely to keep mining contractors well supported in 2011 with demand for engineering services tipped to outstrip supply and the prospect of more corporate deals in the wing.

The outlook is in stark contrast to earlier this year when several project deferrals prompted a series of profit warnings. However, several contractors have said they are now sitting on record order books.

This has led Merrill Lynch to question if the sector is heading back to “the super cycle" as the pipeline of projects is bulging with more than $275 billion of work yet to be awarded over the next three years.

“We expect the contracts associated with this pipeline will start to be awarded in earnest in 2011 given recent project approvals at major projects," Merrill Lynch’s analyst, Kevin O’Connor, said.

He expects engineering and construction activity to grow to $76 billion over the next 12-months - nearly one third more than what was recorded in calendar 2008 with labour intensive components of work making up at least $20 billion of this.

Some of the key projects expected to start or move into the next phase of construction include: BG Group’s Curtis Island project, Woodside Petroleum’s Pluto gas field, the expansion of iron ore facilities by Fortescue Metals Group and Rio Tinto, and the massive $43 billion Gorgon gas project.

The earnings impact will only flow to bottom lines from 2011-12 onwards, although the new year is expected to mark the turning point for the industry, and the broker’s key pick in the space is
Boart Longyear
.

The drilling services company rallied 1.9 per cent early yesterday to a more than two-year high of $4.36 on expectations it could beat its full- year guidance for the period ending December 31, 2010. Management is forecasting earnings before interest, tax, depreciation and amortisation of $205 million but consensus estimates forecast an EBITDA of $214.4 million.

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The Royal Bank of Scotland said that the biggest reason for this gap is based on the belief that the budgeted shutdown period over Christmas will be shorter than what management had anticipated. Other drivers include expectations for rising rig utilisation rates and pricing. Most brokers polled on Bloomberg are urging investors to buy the stock with an average price of $4.77 a share.

Monadelphous Group
might soon come into some profit taking as the stock is looking fully valued following its 35 per cent surge since the start of the financial year.

The group is one of the most leveraged to the expected pick up in Australian capital expenditure given that all of its revenue is generated onshore and supporters would argue that Monadelphous deserves to be trading at a premium to its rivals given its strong management team and good earnings track record.

But the good news could be more than reflected in the current share price with the stock on a one-year forward price-earnings multiple of nearly 16.5 times, a more than 50 per cent premium to its peer group.

The stock is also trading above most brokers’ valuation with the average target priced listed on Bloomberg of $16.90 a share.

However, the group’s joint venture with AnaeCo to build specialised waste management plants could shape up to be an important medium-term growth driver.

The JV has secured funding approval to start building a facility for the Western Metropolitan Regional Council in Perth that can process 55,000 tonnes of solid waste a year and extract the by-products for electricity generation and organic fertiliser production. The success of this facility is likely to kickstart a number of similar projects given the strong demand outlook for sustainable solutions. The stock jumped 13¢ in early trade to $17.25.

In the biotech sector,
Pharmaxis
said that the Australian Advisory Committee on Prescription Medicines has recommended approval of its key drug Bronchitol for marketing in Australia for the treatment of cystic fibrosis.

The news is an important sentiment driver for Pharmaxis ahead of the next catalyst for its stock - the European approval for the drug.

While the stock inched up only 1¢ in morning trade to $2.92, it has bounced by almost 50 per cent over the past three months and could soon recover all of its loss since late June when it shocked investors with the result of its US phase 3 trial for Bronchitol, which missed statistical significance.

The stock fell from $3.12 to about $2 over the next several weeks before recovering as brokers decided that Pharmaxis still had a good shot of getting US regulatory approval for the drug. All brokers polled on Bloomberg rate the stock a “buy", with an average price of $4.03.

The prognosis for
DWS Advanced Business Solutions
isn’t as promising. Shares in the enterprise information technology services company may have jumped 5.1 per cent in afternoon trade to $1.34, but its upside is limited after it warned at the start of December that its first half EBITDA is likely to fall to between $12 million to $12.5 million from the reported $13.4 million during the same time last year.

The profit warning was driven by
Telstra
forcing third party contractors to take a longer than expected break over the Christmas and New Year period. While this may not sound significant, RBS said this impost will have a significant impact on DWS given that Telstra accounts for about 20 per cent of revenue and the fact that most of its projects are done on time and materials, and are not outcome-based.The broker has cut its earnings per share forecast by 21 per cent and 33 per cent for 2010-11 and 2011-12, respectively, to reflect lower utilisation rates, lower staff numbers and employee churn. RBS has a “sell" recommendation on the stock with a price target of $1.04.

The loss of employees could be an issue over the medium term given that the market for IT professionals is expected to be tight over the next 12 months.

This could prompt investors to switch to
SMS Management & Technology
instead as most experts believe that Telstra’s decision will have only a small impact on its bottom line.